This is an edited version of my Sunday Times article from January 29, 2012.
In a recent Annual Demographia International Housing
Affordability Survey of 325 major metropolitan areas in Australia, Canada, Hong
Kong, Ireland, United Kingdom and the United States, Dublin was ranked 10th in
the world in terms of house prices affordability. The core conjecture put
forward in the survey is that Dublin market is characterized by the ratio of
the median house price divided by gross [before tax] annual median household
income of around 3.4, a ratio consistent in international methodology with
moderately unaffordable housing environments.
Keep in mind, the above multiple, assuming the median
household income reflects current unemployment rates and labour force changes,
puts median price of a house in Dublin today at around €175,000 – quite a bit
off the €195,000 average price implied by the latest CSO statistics. But never
mind the numbers, there are even bigger problems with the survey conclusions.
While international rankings do serve some purpose, on the
ground they mean absolutely nothing, contributing only a momentary feel-good
sensation for the embattled real estate agents. In the real world, the very
concept of ‘affordability’ in the Irish property market is an irrelevant
archaism of the era passed when flipping ever more expensive real estate was
called wealth creation.
What matters today and in years ahead are the household
expectations about the future disposable after-tax incomes in terms of the
security and actual levels of earnings, stability of policies relating to
household taxation, plus the demographic dynamics. None of these offer much
hope for the medium-term (3-5 years) future when it comes to property prices.
Household earnings are continuing to decline in real terms
(adjusting for inflation) in line with the economy. The CSO-reported average
weekly earnings fell 1.2% year on year in Q3 2011 once consumer inflation is
take out. But the average earnings changes conceal two other trends in the
workforce that have material impact on the demand for property.
Firstly, reported earnings are artificially inflated because
the workforce on average is becoming older. Here’s how this works. Younger
workers and employees with shorter job tenure also tend to be lower-paid, and
are cheaper to lay off. Thus, the rise in unemployment, alongside with the
declines in overall workforce participation, act to increase average earnings
reported. This explains why, for example, average weekly earnings in
construction sector rose 2.5% in Q3 2011 year on year, while employment in the
same sector fell 4.1% over the same period. This means that fewer potential
first-time buyers of property are having jobs, and at the same time as the
existent workers are not enjoying real increases in earnings that would allow
them to trade up in the property markets.
Secondly, the real world, rising costs across the consumer
expenditure basket, further reducing purchasing power of households, is
compounded by the composition of these costs. One of the largest categories in
household consumption basket for those in the market to purchase a home is
mortgage interest. This cost is divorced, in the case of Ireland, from the
demand and supply forces in the property markets and is influenced instead by
the credit market conditions. In other words, the 14.1% increase in mortgage
interest costs in the 12 months through December 2011, once weighted by the
relative importance of this line of expenditure in total consumption is likely
to translate into a 2-3% deterioration in the total after-tax disposable income
of the average household that represents potential purchaser of residential
property.
And then there are effects of tax policies on disposable
income. One simple fact illustrates the change in households’ ability to finance
purchases of property in recent years: between 2007 and 2011 the overall burden
of state taxation has shifted dramatically onto the shoulders of ordinary
households. In 2007, approximately 46% of total tax collected in the state came
directly out of the household incomes and expenditures. In 2011 the same number
was 58%.
The above factors reference the current levels of income,
cost of living and tax changes and have a direct impact on demand for property
in terms of real affordability. In addition, however, the uncertain nature of
future economic and fiscal environments in Ireland represents additional set of
forces that keep the property market on the downward trajectory. For example,
in Q3 2011 there were a total of 116,900 fewer people in employment in Ireland
compared to Q3 2009. However, of these, 113,700 came from under 34 years of age
cohort. Unemployment rate for this category of workers, comprising majority of
would-be house buyers, is now 20.4% and still rising, not falling. Given the
long-term nature of much of our current unemployment, no one in the country
expects employment and income growth to bring these workers back into the
property markets for at least 3 years or longer. Without them coming back, only
those who are trading down into the later age of retirement are currently
selling, plus those who find themselves in a financial distress.
Tax uncertainty further compounds the problem of risks
relating to unemployment and future expected incomes. Government projections
that in 2013-2015 fiscal adjustments will involve raising taxes by €3.1 billion
against achieving current spending savings of €4.9 billion are rightly seen as
largely incredulous, given the poor record in cutting current spending to-date.
Thus, in addition to already draconian pre-announced tax hikes, Irish
households rationally expect at least a significant share of so-called current
expenditure ‘cuts’ to be passed onto households via indirect taxation and cost
of living increases.
In short, there is absolutely no catalysts in the
foreseeable future for property markets reversing their precipitous trajectory.
No matter what ‘affordability’ ranking Irish property markets achieve, the
demand for property is not going to grow.
This, of course, brings us to the projections for the
near-term future. The latest CSO data for the Residential Property Price Index
released this week shows that nationwide, property prices were down 16.7% in
December 2011 compared against December 2010. Linked to the peak prices as
recorded by the now defunct PTSB-ESRI Index, the latest CSO figures imply that
nationally, residential property prices have fallen from the peak of €313,998
in February 2007 to ca €166,000 today (down 47% on peak). In Dublin, peak-level
average prices of €431,016 – recorded back in April 2007 – are now down to
close to €195,000 (almost 55% off peak).
Using monthly trends for the last 4 years, and adjusting for
quarterly changes in average earnings and unemployment, we can expect the
residential property price index to fall 11-12% across all properties in 2012.
Houses nationwide are forecast to fall in price some 12-14% - broadly in line
with last year’s declines, while apartments are expected to fall 11-12% year on
year in 2012, slightly moderating the 16.4% annual fall in 2011.
More crucially, even once the bottom is reached, which,
assuming no further material deterioration in the economy, can happen in H2
2012 to H1 2013, the recovery will be L-shaped with at least 2-3 years of
property prices bouncing along the flat trendline at the bottom of the price
correction. After that, return toward longer-term equilibrium will require
another 1-2 years. Assuming no new recessions or crises between now and then,
by 2015-2016 we will be back at the levels of prices recorded in 2010-2011.
Between now and then, there will be plenty more reports about improving
affordability of housing in Ireland and articles about the proverbial foreign
investors kicking tyres around South Dublin realtors’ offices.
Chart: Residential Property Price Index, end of December
figures, January 2005=100
Source: CSO and author own forecast
Box-out:
Ireland’s latest shenanigans in the theatre of absurd is the
fabled ‘return to the bond markets’ with this week’s swap of the 2 year 4.0%
coupon Government bond for a 4.5% coupon 3-year bond. The NTMA move means we
will be paying more for the privilege to somewhat reduce the overall massive
debt pile maturing in 2014, just when the current Troika ‘bailout’ runs out. So
in effect, this week’s swap is a de fact admission by the state that Ireland
has a snowball’s chance in hell raising the funding required to roll over even
existent debt in 2014 through the markets. Which, of course, is an improvement
on the constant droning from our political leaders about Ireland ‘not needing a
second bailout’. Of course, as far as our ‘return to the markets’ goes – no new
debt has been issued, no new cost of financing the state deficits has been
established in this swap. The whole event is a bit of a clock made out of jelly
– little on substance, massive on PR, and laughable from the functionality
perspective.
Per charts (source for the chart is CSO):
